How Do I Value My Business?
Or ‘What Is My Business Worth?’
It is a really common question that is rarely ever answered with any commitment. The answer commonly given is that a business is worth what someone else will pay for it. True, but it never really answers the question you asked.
The problem is that valuing a business is such a moving beast. Ask yourself is the value put on Twitter was right? The share price started out at USD$63 after listing, it is now USD$25, so was the price at the outset correct? The figures would suggest not. The flip side is Royal Mail who’s share were listed at £3.30 and now trade at £4.35 having hit a high of over £6.
Even those companies with a breadth of experts don’t get company valuations right.
Essentially though, there are a few basic methods that can be used.
The 5 Methods to Value My Business
When you start to get underneath everything there are a few regular ways to value a business. Each looks at different aspects of the company and each would be used differently in different industry sectors.
The 5 most common methods to value a business are;
- Assets – This method is appropriate if your business has significant tangible assets. For example, a property business or a tech company with lots of Intellectual Property (IP)
- Price/Earnings ratio – This method is appropriate if the business is making sustainable profits or has a higher than average profit margin
- Entry cost – This method values a business by reference to the cost of starting up a similar business from scratch
- Discounted cashflow – This calculation is based on future cashflow. It is appropriate for businesses which have invested heavily and are forecasting steady cashflow over many years. It is often seen with a business during the Growth stage of it’s life cycle
- Industry rules of thumb – This method uses an established, standard formula for the particular sector. Every sector differs in how this is calculated
Let me put this in a little more detail.
Value My Business – Assets
- For property, manufacturing or tech businesses then the starting point is what the asset valuation is on the balance sheet
- The balance sheet figures give you the Net Book Value (NBV)
- The NBV is then refined to reflect economic reality, this means amending values to make allowance for;
- Property which has appreciated in value and worth more than the balance sheet shows
- Old stock which is no longer sellable at standard prices
- Discounting debts that are not going to be paid
- Changing any provisions or overpayments which are not reflective of reality
There was a common practice of discounting software or in tangible assets, however this is less prevalent now as software can be the major asset in the business.
Where a business is going to be closed or is already in distress, hence the sale, then allowance will need to be given to;
- Whether assets will be sold off cheaply
- Redundancy or severance costs
- Exiting premises and/or leases
- Whether debt collection will become more difficult
Value My Business Price/ Earnings Ratio
This is where a business is being valued based on a multiple of it’s profits. The multiple used varies widely and really is open for interpretation, often the biggest question is ‘How much do I want to buy this business?’
- Listed companies have shares that are easier to sell, they typically attract a much higher multiple of earnings than a small unlisted company
- What have companies in your sector sold for locally? Check local press, business trade magazines etc
- What do future earnings look like? Is there a one off good year or are future profits expected to improve exponentially
- Businesses with repeat year on year profits will attract a higher multiple
When calculating profit then there will be several alterations made to the figures, these include;
- Any one off or exceptional items being removed
- Any interest or finance charges that are being repaid need to be removed
- Any unnecessary leases, properties or labour needs to be amended
- Any additional borrowing required to enable the purchase needs to be added in and profits reduced accordingly
Value My Business – Entry Cost
This is where you compare the cost to entering the market as a new company with the cost of purchasing an existing trading business. For this you would consider;
- Cost to purchasing assets
- Raising finance
- Developing products
- Building a customer base
- Brand name or local reputation
The considerations as to whether you pay a premium for the business would largely be based around;
- Could I save costs by using better technology
- Are there other efficiencies I could instigate
- Do I want the premises or location the business has
- Could I develop the products further and/or open new markets to sell to by using the existing business’ name and client base
Value My Business – Discounted Cashflow
This is by far the most technical or forensic way to value a business. It depends heavily upon assumptions about long-term business conditions, market changes and demand.
It is a method used where the underlying business is stable and mature. Good examples of this are utility companies;
- The valuation is based on the total of the dividends forecast over an extended period of time, say 10-15 years
- Over and above this there is a premium added
- Inflation is taken account of, bearing in mind that the buying power of £100 now will be greater than the buying power of £100 in 15 years time
If you are looking at this method of valuing your company then you will already have advisers and senior financial aides involved.
Value My Business – Rule of Thumb
In some industry sectors, buying and selling businesses is common. A good example of this is in franchising where it is common to see outlets or franchises sold among franchisees. This leads to the development of sector wide rules of thumb.
Rule of Thumb valuations are based on factors other than profit, examples are;
- Turnover for a maintenance based business
- Volume of sales where a mail order or internet selling business is concerned
- Number of customers. Typically used for a mobile phone airtime provider or broadband reseller
- Number of outlets. Commonly used for lettings or estate agent companies
Where volume of sales, customers or outlets are concerned then there is typically an economy of scale involved where the existing structure of your business can be used to reduce costs or increase profit margins.
Summarising Valuing a Business
The bottom line is that there are different ways which are used in different sectors. It is as much about justification of asking price than anything else. You also need to consider why you are valuing a business. Is it to sell, to boost your ego, to raise finance or to tender for work? Different reasons may lead to different valuations.
By Dave Farmer